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Morningstar’s verdict on the 3 most popular ETFs

Our analysts’ takes on Australia’s largest ETFs 

Mentioned: DFA Australia Limited (DGCE), Apple Inc (AAPL), BHP Group Ltd (BHP), iShares S&P 500 ETF (IVV), Microsoft Corp (MSFT), VanEck Australian Equal Wt ETF (MVW), Vanguard Australian Shares ETF (VAS), Vanguard MSCI Intl ETF (VGS)

An increasing number of investors are gravitating to ETFs. The 2023 ASX Investor Study showed that the number of Aussie investors using ETFs has risen from 15% to 20% in the space of 3 years. It is particularly popular with new investors – ETFs were the first investment for 14% of investors who got started in the last two years. They’re easy to access, provide instant diversification, and can be used to gain exposure to asset classes that are difficult to access directly.

Here are the three most popular ETFs by funds under management (FUM) in Australia.

1. Vanguard Australian Shares ETF (ASX: VAS)

$14.385 billion (at 31/12/2023)

The Vanguard Australian Shares ETF VAS follows a passive strategy, aiming to replicate the S&P/ASX 300 index.

Our analysts believe that this ETF is a compelling choice for core Australian equity exposure, awarding it a Bronze medalist rating. Our ratings are based on expectations for risk-adjusted future performance comparative to a category benchmark. This contrasts with how many choose ETFs which is based on how well funds have performed in the past.

A diversified index that captures the investment opportunity set well, a highly competitive fee, and Vanguard's well-recognised index tracking and trading efficiencies are the drivers of the continued vote of confidence in the strategy.

When looking at funds, one of the biggest questions is whether to go active or passive. The low price of this strategy sets a significant hurdle for active managers in the same space when looking at net-of-fee returns over the long term. However, our analysts believe that Morningstar’s best-rated active managers can add value and cross that hurdle consistently.

One consideration when looking for broad domestic equity Australia are the unique attributes of the Australian market. BHP Group BHP makes up 11% of the index, and the top 10 holdings make up 46% of the index (at 18 January 2024). The Australian market is very narrow, which means that a handful of sectors and industries dominate, including financial services and mining.

The result of this is inadequate diversification. An answer to this could be an equal-weighted ETF which invests proportionately across the index constituents. The VanEck Australian Equal Weight ETF MVW achieves this across 80 holdings that represent large and mid-cap shares in Australia. The fee is significantly higher than VAS (0.07% total cost ratio) at 0.35%, but our analysts believe this is justified.

They award MVW a Silver Medalist rating and think it is a great way to get exposure to the Australian market because it is diversified.

You’re able to read more about the trade-off between market-cap and equal weighted passive ETFs in this article I have written.

2. Dimensional Global Core Equity Trust (ASX: DGCE)

$6.727 billion (at 31/12/2023)

Our analysts believe that Dimensional Global Core Equity Trust DGCE is a great pick for investors seeking a diversified global equity portfolio. The fund offers exposure to listed companies across the market-cap spectrum from foreign developed markets. It excludes emerging markets. Historically, the fund has maintained a palpable bias to North America at the expense of Europe and Asia.

Resting on the research of renowned academics such as Eugene Fama and Kenneth French, the strategy tilts toward stocks with lower valuations (measured by price/book ratio), smaller market caps, and higher profitability (using an adjusted measure of operating income). Evidence shows that stocks with these characteristics have tended to outperform over the long term. The fee (0.36%) is among the lowest relative to rival active peers.
The fund offers a representative and well-diversified portfolio. Despite an extended period when value-oriented funds faced headwinds through the past decade, the fund has only marginally underperformed the average return of the world large-blend Morningstar Category. The fund held up relatively well in the 2022 calendar year compared to category peers, as equity markets around the world slid.

Overall, with a low expense ratio, the fund has the potential to deliver superior long-term risk-adjusted returns relative to peers.

The Vanguard MSCI International ETF VGS, however, is awarded a gold medalist rating by our analysts for core global equity exposure. It follows the MSCI World ex Australia index. Our analysts cite how cheap the fees are, the liquidity/ease with which you can move into and out of the ETF, the diversification and the track record that Vanguard has of being able to match the index returns.

The ETF includes exposure to 22 developed market countries and over 1500 large and mid-cap companies.

There are two considerations to note. It excludes emerging markets countries such as China and India. While it is allocated to 22 countries, over 70% is allocated to the United States.
For those looking for a simplistic portfolio, as many are when they invest in ETFs, this addresses the above concerns. If this was a representative index that did not exclude emerging countries, China would make up 3.7% of the index, and India would make up 1.8%. Small exposures.

When we look at the overall market, it is heavily weighted to the US as US companies make up a huge portion of publicly traded equities. Many of the giant US companies represented in the index are global, selling products around the world. From this perspective, investors are receiving exposure to many more economies than just the US. I’ve given a few examples in this article.

In terms of exposure to countries like China and India, it is important to remember that depending upon the country the share market can be more or less representative of the overall economy. In the US, the share market is highly correlated to the overall economic activity of the country. This isn’t the case in China. There are more private companies and more government control. If we look at the US and Chinese share markets, the US is more than four times the size of China’s share market. The economies are closer in size. The fee for VGS is low at .18% and due to liquidity, the buy/sell spread is the lowest out of diversified global equity ETFs in Australia. This is an underappreciated cost of trading and will make a difference if you are frequently making contributions into your portfolio.

3. iShares S&P 500 ETF (ASX: IVV)

$6.664 billion (at 16/01/2024)

Many passive Australian investors are anything but. They deviate from this strategy by making active decisions to be overweight in certain sectors, themes or geographies. It is no secret that Australian investors prefer and are heavily invested in domestic markets.

However, Australian investors have started to double down on the US as well. This may be due to the US outperforming almost every other market since the GFC. It is no surprise that iShares S&P 500 ETF IVV makes the top three.

Given the breadth of coverage and the cost efficiency, iShares S&P 500 ETF IVV is a fine choice for investors seeking US-specific equity exposure. The strategy is expected to outperform its peers over the long term and remains the clear choice for investors to gain US exposure. It can be paired with other ex-US products to form a balanced global equity portfolio.

The underlying benchmark, the S&P 500, is a market-cap-weighted index of the largest 500 companies in the United States. Thus, it offers giant- to mid-cap exposure, covering about 80% of the free-float-adjusted market cap of the US equity market. This results in a well-diversified index at the stock and sector levels. As such, passive strategies that track the S&P 500 stand as above-average options in a market segment where active managers have generally struggled to outperform. Consisting of highly liquid stocks, material stock-specific valuation information is quickly incorporated into stock prices.

From an Australian perspective, IVV gives exposure to a broad portfolio of some of the world’s most noteworthy companies, including sectors that are underrepresented in Australia such as technology and healthcare. The S&P 500’s correlation to Australian equities has come down in recent years, effectively adding to diversification for Australian equities exposure. It earns a silver medalist rating.

At an annual fee of 0.04%, the fund is priced attractively compared to active and passive peers.

When we look to the index’s exposure, 51% of the index is in the top 10 holdings, over 7% of the index is in one holding – Microsoft MSFT, 6.75% in another – Apple AAPL. The index is highly concentrated in tech, with almost 30% of the index in this sector (at 12 January 2024).

Can you create a portfolio with 3 ETFs?

We’ve explored how to pick a portfolio of 3 ETFs in this Investing Compass episode.

You are also able to listen to this episode on Apple Podcasts, Spotify or Google Podcasts.

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